[Fragmented Investment Rising]④Challenges Including Asset Valuation Objectivity and Tax Application Accumulate

Art Fragment Investment Expected to Become Popular Fast
Criticism That Price Evaluation Standards Are Not Objective
Government Reviewing Taxation System... Tax Law Application Also a Variable

Editor's NoteFractional investment is regaining attention. This is because regulations related to fractional investment are expected to be gradually lifted. Last year, financial authorities recognized fractional investment as a type of financial investment product called 'securities.' This has established a legal basis for conducting business legitimately. Additionally, the possibility of trading on the Korea Exchange, similar to stocks, is opening up. Fractional investment, where multiple people invest in physical assets and hold divided shares, has gained great popularity in recent years due to the ability to invest in high-value assets with small capital. Expectations are also rising that the related industry could grow as legislation has been proposed to register token securities issuance (STO) using blockchain as electronic securities. However, many still do not understand the concepts properly, often confusing fractional investment with STO. This article examines the background of incorporating fractional investment and token securities into the regulatory framework, the reasons why the securities industry is entering the fractional investment business, and the concerns in the market.

Stanley Whitney's 'Untitled' work exhibited at K Auction's February 2022 auction. (Photo by K Auction)

There are both expectations and concerns regarding the fractional investment market. For example, in the case of artworks, which are the most notable underlying assets for fractional investment, it is pointed out that it is difficult to establish objective criteria for asset valuation. When issuing stocks, the public offering price is set based on objective criteria and formulas such as corporate performance. However, in fractional investment, each platform arbitrarily evaluates asset prices. If the price is set higher than the actual market trading price, it may be difficult to exit (recover investment) later.

What if you get stuck at the peak of fractional investments in artworks or real estate?

Let's look at the product of TogetherArt, which submitted the first investment contract securities registration statement. The fractional investment product issued by TogetherArt is a work titled 'Stay Song 61' by American artist Stanley Whitney. K Auction purchased it in March 2022, and TogetherArt, an affiliate of K Auction, offered it as a fractional investment product.

According to the securities registration statement submitted by TogetherArt to the Financial Supervisory Service, the estimated value of the artwork is between 720 million KRW and 800 million KRW. The basis is the auction prices of 83 works created between 1991 and 2019. Prices were calculated based on winning bids from Christie's, Sotheby's, Phillips, Seoul Auction, and K Auction from 2013 to March of this year.

In November 2015, at the Boetto auction in Italy, a 2006 work (Wonder Garden) was sold for $13,894 (approximately 18.5 million KRW). This work is relatively large, measuring 136.0 cm in width and 152.0 cm in height. In November 2022, a work (Blue in Green, 2005, 101.6*101.6 cm) sold at Phillips fetched $327,600 (approximately 434 million KRW). This means the artwork price increased by 2245.9% over seven years.

However, artworks tend to have high price volatility depending on the production period, artistic value, economic conditions, and auction houses. Looking at auctions held this year for works similar in size to the fractional investment target 'Stay Song 61' (101.9 cm width and height), price fluctuations are significant.

Works sold at auctions this year ranged in size from 182.9 cm to 190.5 cm in width and 182.9 cm to 223.5 cm in height. Winning bid prices varied widely from $609,600 to $1,294,258. The production years ranged broadly from 1997, 2009, 2013, to 2019. Based on the 2019 production year of the fractional investment artwork, the winning bid prices for similarly sized works ranged from $500,000 (approximately 662.5 million KRW) to $1,580,000 (approximately 2.0935 billion KRW).

Reflecting this, the securities registration statement disclosed that "Interest rate fluctuations and economic fluctuations can cause a decline in the market value of artworks, which are the underlying assets," and that "investor sentiment contraction, reduced liquidation possibilities due to demand stagnation for the underlying assets, and other stages may be affected by financial market volatility." It also added that "If domestic or foreign economic slowdown or recession occurs, it may negatively impact the market valuation of the underlying assets in the portfolio." Considering all costs and fees, there is a possibility of losses in the worst-case scenario.

How is tax applied?

Taxation is also a consideration. If related policies such as the introduction of holding taxes on the art market are legislated, or if tax authorities' interpretations or practices regarding tax laws change, leading to higher tax rates, the art market could shrink.

According to the 2020 tax law revision, capital gains from art sales, which previously lacked clear income classification, were specified as miscellaneous income. Article 129, Paragraph 1, Item 6 of the Income Tax Act states that income from the transfer of calligraphy, paintings, and antiques is subject to a flat 20% withholding tax.

If the transfer price exceeds 100 million KRW, up to "90 million KRW + 80% of the amount exceeding 100 million KRW" (up to 90% if held for more than 10 years) can be recognized as necessary expenses. While policies are being pursued to ease barriers to art transactions by reducing art tax rates, fractional investment has a different nature.

Under current law, unlike stocks, investment contract securities are not subject to securities transaction tax, and value-added tax is not applied to art transactions. Fractional investment products are issued as investment contract securities or trust beneficiary certificates. TogetherArt judged that for investment contract securities based on artworks, it is reasonable to classify income according to the transfer of the underlying artwork.

From January 1, 2025, under the revised Income Tax Act, investment income tax may be levied when transferring investment contract securities. Although the law does not currently include gains or losses from the liquidation of investment contract securities in the scope of investment income tax, there is a possibility that investment income tax will be applied when fractional investment products are liquidated in the future.

TogetherArt stated, "If tax laws change, it could negatively affect business and joint venture profitability, as well as the final liquidation gains or losses attributable to investors."

The Ministry of Economy and Finance and the National Tax Service are reviewing how to apply the tax system to fractional investment transactions. This means that taxes will differ depending on whether the standard is based on physical assets or stocks/funds. They are conducting legal interpretations and are reportedly examining cases from other countries through external consulting.